Tuesday, October 3, 2023

401(k) Versus Pension Plan?

The IRA and 4019(k) were experiments that largely have failed most Americans.  But are Pension Plans any better?

The UAW strike continues, although it looks like Ford has settled with the Canadian union, and "Stellantis" is close to settlement.  One of the sticking issues is the 401(k) plan for new hires.  The Union wants to go back to a defined-benefits pension plan, which could be a good thing for the workers, but could be a disaster if, like with the Teamsters Union, the Union administers the pension plan.  See, e.g., Fox v. Henhouse.

But beyond union corruption lies real problems with both types of plans.  When the IRA or 401(k) came out, some professionals saw it as a godsend.  For Engineers, for example, a work history might include a few years spent on one project at Company A, and a few more years at Company B at another project, and so forth.  Over time, you might have worked for three or four or more companies, and never worked long enough to "vest" your pension (usually five years, back then) or, even if vested, havnig little to show for it in terms of pension.  As a result, end up retiring with no savings, other than what  you could scrape together in an after-tax investment account.

For example: My Dad worked for a number of companies over the years - at least six by my count.  He never stayed long enough at any one company to be vested in a pension plan until his last company, where he worked for 18 years - and earned a whopping $29,000 a year in pension payments.  Better than nothing, but if all those other companies he worked for had chipped in, he would have had more than double that. Sweet deal for a company when someone doesn't vest!  And historically, companies have fired employees when they are only a few days shy of vesting.  What's not to like about that?

The 401(k) allowed professionals to take their retirement money with them - no vesting required, other than for "matching" funds.  So, over the years, you could accumulate a nest egg, which would also reduce your tax bills during your prime earning years.  For professionals, who presumably know how to use a calculator, it was a good deal.  But even then, there were professionals who didn't save or save enough.

For the blue-collar worker, less so.  Many didn't have the intellectual wherewithal to see how the plan works and to properly fund it.  For low-paid workers, such plans are often a cruel joke - they are already living "paycheck to paycheck" and can't afford to put money into a 401(k) even if it is matched by the employer.  Worse yet (and I have seen this firsthand) is that they accumulate $10,000 in their 401(k) after years of heroic savings and then blow it all by borrowing against the plan and paying more in interest than they would be earning.

Even if a low-wage employee saved 10% of their income and was matched by their employer, after 30 years, they would have hardly enough to retire on, or not enough at all.  Using the 4% rule for retirement, savings of ONE MILLION DOLLARS would provide only $40,000 in income in retirement.  Maybe that is enough to "get by" today (if you have no debts and live frugally) but in 30 years, I suspect forty grand won't buy you a hamburger.

And to save up a million bucks, you'd have to sock away ten grand a year for 30 years and earn 7% on that income.  Even a half-million dollars would require a heroic amount of savings for a low-wage earner.

Some have proposed making 401(k) deductions mandatory or at least the default option.  This might help the professional or executive worker, but it won't do much for the low-wage worker.

So the 401(k) plan is flawed.  The IRA is even worse, with its pitiful contribution limits ($2000?  Get real!).  The IRA is really only useful as a rollover mechanism for your 401(k) when you leave a company.

So what about pensions? Well, pensions sound cool, and in reality, they are a relatively modern invention. I have friends who worked in government (school teachers, for example) and they have vested pension plans. They get $X dollars a month, with adjustments for inflation.  They live as retirees as they lived as employees - buying things using loans and mortgages.  So long as those pension checks keep coming in, they are set.  And since they have a relatively high income, the home mortgage tax deduction works for them - even in retirement.

But since 1978, when the IRA was invented, more and more companies have shed pension plans and instituted 401(k) plans.  In some regards this was a good thing, in others, it was just a way to scam people.  Many companies (and governments) failed to properly fund pension plans.   You run a car company and need to spend $1B to develop a new car model.  If you don't, you go broke as no one wants to buy a 10-year-old design.  So you spend the money on that and decide not to fully fund the pension plan for now, and you'll "catch up later" when the new model sells well.

(Of course, sometimes companies under-fund pension plans not so they can invest in new technology, but to give the stock-price a one-time boost and thus cash-in on executive stock options.  Act shocked).

Sadly, this is the same thing that happens, on a smaller scale, with 401(k) plans.  Busy parents decide to spend now on a new roof or braces for the kids, and figure they will "catch up" on their retirement plan later on.  Playing catch-up is hard, if not impossible to do.  The more you can front-end load any investment plan, the better off you are.  A dollar invested at age 20 is equivalent to $21 invested at age 65. Try playing that catch-up game!

Making matters worse is the fact that automation and shrinking market share has meant that retirees often outnumber actual workers.  When you go from having 60% of the domestic auto market to less than 20%, something has to give - which is why, in part, GM went bankrupt.

Speaking of GM, I was searching online about Opel, as GM used to sell Opels as Buicks in America, even Opels that were Izuzus made in Japan on the Chevette platform.  The car business is crazy.  Anyway, GM was losing money on Opel, so they sold it to PSA, which in turn was bought up by Stellantis, which used to be Fiat.  GM once tried to buy Fiat, spending billions on a purchase agreement and then spending billions to get out of the deal.  To make matters worse, as part of the deal, they let Fiat use Opel platforms to build cars, so GM effectively funded their whole R&D.  And now Stellantis (which sounds like the name of an Italian beer!) bought PSA and now owns Opel.  What an incestuous business!

But this nugget jumped out at me:

In March 2017, the PSA Group agreed to buy Opel, its English twin sister brand Vauxhall and their European auto lending business from General Motors for US$2.2 billion.[41][42] In return, General Motors will pay PSA US$3.2 billion for future European pension obligations and keep managing US$9.8 billion worth of plans for existing retirees. Furthermore, GM is responsible for paying about US$400 million annually for 15 years to fund the existing Great Britain and Germany pension plans.[41]

Read those numbers again.  Let me translate it for you: "Here, PSA, I will give you a car company, lock stock and factories, and pay you a billion dollars in cash, AND will pay the pensions of the retired workers to the tune of a half-billion a year!"

PSA: We reluctantly accept your proposal.

Even if PSA just shut down the plants to eliminate a competitor, they come out ahead on the deal.  As it was, PSA was socked with such an unprofitable company that they later folded into Stellantis.

The deal illustrates how unfunded pension plans can sink a company, and how pension liabilities can dwarf other obligations, over time.

And in some instances, companies go bankrupt - by default or by design - and leave pensioners with less than half of what was promised.  The Pension Resolution Guaranty Corp usually pays 40 cents on the dollar for pensioners with busted plans. This can turn a comfortable retirement into a penny-pinching nightmare in a real hurry.

And as I noted before, some "free enterprise" mavens like Mitt Romney, ran a company (Bain Capital) that specialized in killing off ailing corporations, spinning off the pension liabilities into designed-to-fail subsidiaries and then cashing out on the remaining carcass.  The pension plan is never 100% secure, while the 401(k), when rolled over to an IRA, usually is.

Well, that is, unless the IRA owner decides to do something stupid like put all his money into risky tech stocks.  You can lose it all, just like at a Casino.

The defined benefit pension plan is, in a way, like an annuity.   And I have friends who have purchased annuities as their retirement plan.  They are not a bad idea, but I would not suggest putting all your money into an annuity, but rather only part.  An annuity is just a contract between you an the annuity company (usually an insurance company) to pay you $X every year once you retire, in exchange for you investing $Y in the annuity, either as a one-time payment or over a period of years.

Contracts can be broken.  Annuity companies can go broke.  They take in money from customers and pay it out on the basis of average life expectancy and a guaranteed, but mild, rate of return.  They take this money and try to play the market and get back a higher rate of return than is paid out.  Sometimes they fail at this.  Some States insure annuities, but again, odds are you get back only a portion of what was promised.

Social Security is like an annuity that is chronically underfunded.  And in terms of a "contract" it is a contract where one party to the contract (the government) can change the terms at any time or even abolish the whole thing - as Republicans keep promising to do (and Social Security pensioners keep voting for - stupid!).   The plan is continually underfunded so that it is designed to fail.  Playing "catch-up" will mean the next generation gets socked with a hefty payroll tax, even if they pay no income taxes.

So you see a pattern here - whether it is an annuity, social security, defined-benefit pension, or 401(k) plan, these plans are all based on a promise to pay at a later date, an in every case, people fail to properly fund these promises, leading to a "crises" down the road.  A crises of their own making.

We'd all rather have a jet-ski today rather than put ten grand in our 401(k) - ten grand that could be worth 50 grand only a decade or so later.

Whether the UAW gets its way and goes back to a defined-benefit pension plan remains to be seen. Non-union plants in the USA (every foreign manufacturer) offers little or no benefits, or if they do, a half-hearted 401(k) plan.  If the UAW gets it way, the "Big 3" (which are no longer big!) will have to jack up prices or cut content on their products, to compete with these non-union plants.  Tariffs don't work when your foreign competitor has a factory in your home country.  I suspect that either way, it will be a return to the 1970s, where quality was poor and prices were high, and people looked across the street at the Toyota dealer more often.

Sure, Ford can get by selling the F150 and the Explorer for staggeringly high prices - for a while, anyway. But the Japanese offer their own lines of pickup trucks, and every year, they get better and better.  The Toyota T100 when it first came out, was a bit of a bad joke (having the same four-cylinder engine as their smaller, unnamed truck had).  Today, the "Tundra" is a worthy competitor to the F150, even if they don't have a line of 3/4 and 1-ton trucks to match.

But give them time.... they will.

Ford's CFO is claiming that "pensions are a thing of the past" and maybe the executives hope for that.  But it fails to explain why Ford caved-in on this in Canada.  Frankly, I don't think the modality is important.  Whether it is a defined-benefit pension, a 401(k) program, an annuity, or Social Security, all of these plans are based on promises and keeping promises - whether to others or ourselves.

If companies fail to fully fund their pension plans, or workers fail to make 401(k) deductions from their paychecks, or annuity companies fail to invest properly, or Republicans gut Social Security, these promises won't be kept.

And in the end, we are merely breaking promises to ourselves, which should be the easiest promises to keep!